By the standards that geezers like me used to live by, Canadian interest rates are still extremely low. What used to be the benchmark long bond, a 30-year instrument that will finally mature in 2021, carried a coupon of 9.75 percent. That was the risk-free rate that the government of the day had to pay back in the early 1980s.
Still, bond yields are definitely on the rise right now, with the 5-year Canada trading near 2.2 percent and the 10-year above 2.3 percent. Rates in the US, where the Federal Reserve is seen as bent on tightening, are higher still, with the 10-year Treasury at 3 percent for the first time since 2014. Canadian banks have taken heed, and today the two biggest -- TD and Royal -- hiked their fixed mortgage rates. TD boosted its 5-year rate, the most popular choice among borrowers, by 0.45 percent, to 5.59 percent.
The Canadian housing market is already struggling to regain momentum, and these rate moves -- which are all but certain to be followed by the other banks -- must surely put the final nail into realtors' lingering hopes for a rebound later in the year. That may be no bad thing: the markets in Toronto and Vancouver are still overvalued by historical standards. However, with household debt still at elevated levels, it is very likely that the upward trend of interest rates will bite into household consumption, and thereby into overall economic growth.
What are the bond markets worried about? It doesn't seem to be excessively rapid growth and the risk of overheating, at least for now: both the Canadian and US economies have slowed from the pace seen a year or two ago. That means, in turn, that concerns over a return to much higher levels of inflation cannot be the primary factors driving rates higher. Although inflation rates on both sides of the border have edged higher, the increase is mainly the result of higher energy prices. Labour markets look tight, but there is little sign of the sort of upturn in wages that would get either the Fed or the Bank of Canada seriously concerned.
Rather, the concerns seem to be about the fiscal outlook in both countries. The fiscal stance of the Trump administration is breathtakingly rash, providing a reminder (if one was needed) that Republicans are only fiscal hawks when Democrats are in power. Choosing this moment to antagonize the biggest buyer of US debt -- China -- by threatening to start a trade war seems foolish indeed, though these days it can hardly be called surprising.
Meanwhile in Canada, the Liberal government up in Ottawa is projecting deficits as far as the eye can see. In Ontario, the world's largest non-sovereign debtor, the Auditor-General is again arguing that the Provincial deficit is far larger than the government wishes to admit -- indeed the A-G denies that the government ever got the budget back into balance, as it claims to have done. It remains to be seen whether Doug Ford's PC party, which looks likely to be the winner of the election in early June, will be able to do much better on the fiscal front.
In short, it looks as if good old supply and demand offer the best explanation for the upward trend in bond yields. After the financial crisis, when private corporate borrowing shrank very sharply, markets were easily able to absorb government debt, particularly with the Fed helping out via Quantitative Easing. QE is being scaled back and private sector financing needs are getting back to normal. If you're a Keynesian you'll know that this is not the stage of the business cycle for governments to be stepping up their own borrowings, but that's what's happening, and that's why rates are likely to keep heading higher.
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